Question on start ups that pay employee's COBRA premium from former employer until they have sufficient employees in CA (home state) to qualify for a group plan.

[Guest llerner]

A start up will pay COBRA premiums for new employees until they have enough employees in California to quality for a group health plan since most of them are out of state currently. The maximum head count will be under 20 once the company is in place.

Since the premiums are paid by the new employer for the COBRA premiums for continuation coverage from a previous employer on behalf of their new employee, two questions:

1) Are these COBRA premiums deductible to the corporation as an expense if they provide this for all the new employees in lieu of a group health plan?

2) Are these premiums tax free to the employee or taxable income?

I know that most do treat them the same as group benefits and have had no tax issues but wondering if it is sanctioned by IRS or not. On one hand, they are the new companies employees and these are employee benefits. On the other hand, the benefits are not tied to the current employer but to the previous employer.

I would really appreciate your help on this because I looked through tax facts 2005 and other publications and could find no mention of this.

THANK YOU!

[Alf]

Deductible and exempt from tax under Code Section 106. No nondiscrimination rules. It must be set up as directed payment and the employer must recieve documentation of payment. The new employer can't just give discretionary cash to new employee for any purpose.

[Guest llerner]

Thanks so much for your answer I really do appreciate it. I did get some conflicting information from HR Next ask a question They are not accountants however and their opinion is more of a legal opinion. Anyone else have input? See the other answer below. THANKS!

Issues related to the taxation of premiums paid for group health insurance are regulated by ERISA and different parts of ERISA are administered by different Federal agencies. In general, the Internal Revenue Service (IRS) administers the taxation of contributions and benefits.

Welfare plans. All forms of health care, life insurance, prepaid legal services, and disability insurance (both long- and short-term) are considered "employee welfare benefit" plans. Unfunded benefits or payroll practices, such as vacation, holidays, overtime premiums, holiday gifts, and compensation paid for time not worked, are not included. Group-type voluntary insurance programs to which the employer makes no contribution are also excluded.

In the case you describe, the employer is not setting up a group health insurance plan. Rather, it is paying the employees additional compensation to cover the cost of continuing their health insurance under COBRA. It is our understanding that the amount of the COBRA payments would be taxable income to the employees. However, the amounts paid by the company would likely be included in operating expenses when the company calculates it taxes. For additional information on the tax consequences for the company, you may want to consult with an accountant.

We hope this information is helpful. Please let us know if you have additional questions.

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[Don Levit]

I am wondering if the employer reimburses the employees for the after-tax premiums paid by the employees, if this may qualify under the 1961 revenue ruling, as deductible by the employer and non taxable to the employee?

Don Levit

[Guest llerner]

Yes, they are requesting a proof of payment from the employees prior to reimbursement. They do not want to give them any funds without this.

[Alf]

it is paying the employees additional compensation to cover the cost of continuing their health insurance under COBRA. It is our understanding that the amount of the COBRA payments would be taxable income to the employees.

Again, this is just wrong. Code Section 106 provides that the gross income of an employee does not include contributions which the employee’s employer makes to an accident or health plan for compensation (through insurance or otherwise) to the employee. HRAs are also allowed to reimburse premiums for other health insurance coverage, such as a COBRA premium, so that is probably additional proof that one employer's payment of premiums on an individual policy or a former employer's policy is tax free to the employee.